working capital and lead/lag - hydro one · updated: february 23, 2007 eb-2005-0501 exhibit d1 tab...

Updated: February 23, 2007 EB-2005-0501 Exhibit D1 Tab 1 Schedule 5 of 2

WORKING CAPITAL AND LEAD/LAG 1

2

1.0 INTRODUCTION 3

4

Working capital is the amount of funds required to finance the day to-day operations of a 5

regulated utility and is included as part of rate base for ratemaking purposes. The 6

determination of working capital relies on a lead-lag study. 7

8

In 1999, the Ontario Energy Board issued a directive in transitional rate order 9

RP-1998-0001 to Hydro One Networks requesting that the Company develop a lead/lag 10

study in preparation for its next rate hearing. In preparation for the 2005 Distribution rate 11

filing Hydro One issued an RFP for the conducting of such a study. Responses were 12

received and evaluated and Navigant Consulting Inc. was selected to conduct the study. 13

Hydro One provided Navigant with information requested during the course of their 14

study and made staff available for interviews and to respond to questions. In the Board’s 15

RP-2005-0020 Decision With Reasons, the Board accepted the results of the submitted 16

Navigant lead/lag study. In 2006, Hydro One Transmission retained Navigant Consulting 17

Inc. to conduct a similar lead/lag study. The following is a summary of the key findings. 18

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2.0 SUMMARY OF KEY FINDINGS: 20

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Hydro One Transmission’s net cash working capital requirement for the 2007 test year is 22

$12.5 million which is 3.2% of OM&A expenses or 0.2% of Rate Base. Working Capital 23

for 2008 is $11.3 million which is 2.9% of OM&A expenses or 0.2% of Rate Base. The 24

methodology recommended is consistent with that used in other regulatory jurisdictions, 25

and it: 26

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Filed: September 12, 2006 EB-2005-0501 Exhibit D1 Tab 1 Schedule 5 of 2 • has considered the most important elements of revenue lags, including the IESO 1

billing lag; 2

• includes the most important elements of expense lead such as payroll and benefits, 3

other operations, maintenance, administration expenses, and taxes, including property 4

taxes; 5

• takes the major cost elements into consideration in calculating the net cash working 6

capital. 7

8

Hydro One Transmission has accepted the Navigant report as presented in Attachment A, 9

and has incorporated the findings into the calculation of Revenue Requirement. 10

11

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Filed: September 12, 2006 EB-2005-0501 Exhibit D1-1-5 Attachment “A”

A DETERMINATION OF THE WORKING CAPITAL REQUIREMENTS OF HYDRO ONE’S TRANSMISSION BUSINESS Prepared For:

Hydro One Networks Inc.

July 19, 2006 Prepared by: Navigant Consulting, Inc. 2508 Muirfield Road Springfield, IL. 62711 217 787‐5180 www.navigantconsulting.com

TABLE OF CONTENTS

I. Introduction and Summary

1.1 Working Capital and Lead Lag Studies 1.2 Method 1.3 Organization of the Report

II. Revenue Lags

III. Expense Leads

III.1 Operations, Maintenance, and Administration (OM&A) Expenses III.2 Payroll and Benefits III.3 Payments made to Consulting and Contract Staff III.4 Payments to Inergi III.5 Payments for Trinity III.6 Property Taxes III.7 Procurement Card Payments III.8 Other (Miscellaneous) Operations and Maintenance Expenses III.9 Removal Costs III.10 Environmental Remediation III.11 Interest on Long Term Debt III.12 Income, Capital, and Large Corporation Tax III.13 Goods and Services Tax (“GST”)

IV. Working Capital Requirement V. Comparing the Hydro One Transmission Lead Lag Study with Other Canadian Studies V.1 Customer Revenues V.2 IESO/ISO Revenues V.3 Other Revenues V.4 Payroll, Withholdings, and Employee Benefits V.5 Cost of Power or Other Fuels V.6 Other Operations, Maintenance, and Administration Expenses V.7 Income and Related Taxes V.8 Taxes Other Than Income V.9 Interest Expense Conclusion: Reasonableness of the Hydro One Transmission Lead Lag Study

LIST OF TABLES Table 1 Calculation of Revenue Lag Table 2 Calculation of Transmission OM&A Expense Lead Time Table 3 Calculation of Hydro One Inc. Payroll and Benefits Expense Lead Time Table 4 Expense Lead Time associated with GST Table 5 Weighted Lead Time on GST Table 6 Summary of Results Table 7 Derivation of GST Amounts Table 8 Benchmarking the Hydro One Transmission Lead Lag Study

I. INTRODUCTION AND SUMMARY

In the RP‐2005‐0020 Decision With Reasons, the Ontario Energy Board (the “Board”)

approved Hydro One (the “Company”) Distribution’s request for a working cash allowance for

the 2006 test year, consistent with the amount recommended in the filed report prepared by

Navigant Consulting Inc (“NCI”). In preparation for a transmission rate filing before the

Board, the Company has retained NCI to prepare a similar lead‐lag study. The purpose of this

report is to provide the results of the lead‐lag study and to determine the cash working capital

requirements of the Company’s transmission business.

The objective of the study was to derive the appropriate leads and lags for deriving the

working capital requirements of the Company’s transmission operations. Where feasible,

transmission business specific data was used in the determination of leads, lags, and net lags;

otherwise Company‐wide activity was evaluated to determine the appropriate net lags to apply

to the Company’s test year transmission‐related expenses. Except where noted, the time period

used in the analysis was calendar year 2005.

In summary, the lead‐lag study applied to the Company’s test year transmission

expenses result in working capital requirements of $12.4 million in 2007, and $11.7 million in

2008. These amounts represent approximately 3.10 percent and 3.02 percent of Operations,

Maintenance, and Administration (“OM&A”) expenses and approximately 0.19 percent and

0.17 percent of rate base in 2007 and 2008 respectively.

I.1. Working Capital and Lead‐Lag Studies

Working capital is the amount of funds required to finance the day‐to‐day operations of

a regulated utility and are included as part of rate base for ratemaking purposes. The

determination of working capital generally relies on a lead‐lag study. A lead‐lag study analyzes

the time between the date customers receive service and the date that customers’ payments are

available to the Company (or “lag”) together with the time during which the Company receives

goods and services but pays for them at a later date (or lead”)1. “Leads” and “Lags” are both

measured in days and are generally dollar‐weighted. The dollar‐weighted net lag (i.e., lag

minus lead) days is then divided by 365 (or 366 if a leap year is selected) and then multiplied by

the annual test year cash expenses to determine the amount of cash working capital required for

operations.2 The resulting amount of working capital is then included as part of the Company’s

rate base.

Two key concepts need to be defined up‐front as they surface throughout the lead‐lag

study described in this report:

Statutory Approach: Not all areas of the Company’s business may utilize dates on which actual payments were made by the Company. In some instances, particularly taxes, the payment due dates are established by statute or by regulation with significant penalties in place for missing the due date. In these instances, the due date established by statute has been used in lieu of when payments were actually made. Mid‐Point Approach: When a service is provided to (or by) the Company over a period of time, the service is deemed to have been provided (or received) evenly over the mid‐point of period, unless specific information regarding the provision (or receipt) of that service is available indicating otherwise. This mid point may be calculated either using the formula:

(Service End Date – Service Start Date + 1)/2

An alternative formula which generates the same results is 365 days in a year/number of periods in a year/2. So for a service provided monthly the mid‐point used may be 15.21 days (i.e., 365 days divided by 12 divided by 2).

Activity over a given twelve month period is used to analyze the timing of payments

and receipts unless interviews with Company personnel reveal that there are known changes to

existing policies or procedures going forward. Where such changes are known, they have been

incorporated into the derivation of the appropriate leads, lags, and net lags. 1 A positive lag (or lead) indicates that payments are received (or paid) after the provision of a good or service. 2 Leads and lags are generally measured using test year activity in terms of cash receipts and payments unless a future test year is used as the basis for ratemaking. In such an instance, the most recent twelve months of activity is generally used as the basis for the measurement of leads and lags.

I.2. Method

Performing a lead‐lag study requires two key undertakings: a) developing an

understanding of how the regulated business works, i.e., in terms of collections and payment

policies and procedures; and b) development of a representative data set that reflects the

implementation of such policies and procedures in terms of the timing of payments received

(sent) at any given point in time.

To develop an understanding of Hydro One’s operations, interviews with personnel

within the regulated utility’s Accounts Payable, Customer Service, Human Resources, Payroll,

and Tax Departments were conducted. Some key questions that were addressed during the

course of the interviews included:

i. What is being sold (or bought)? If a service is being provided, over what time period

was the service provided?

ii. Who are the buyers (sellers)?

iii. What are the terms for payment? Are the terms for payment driven by industry

norms or by company policy? Is there flexibility in the terms for payment?

iv. Are any changes expected to the terms for payment either driven by industry or

internally by the Company? What is the basis for such changes (if any)?

v. How is payment made (e.g., cash, check, electronically)?

The development of a representative data set entailed gathering raw data from the

utility’s Accounts Payable, Customer Service, Payroll, and Tax Systems. Once the raw data had

been gathered from the multiple in‐house systems, sampling and data validation was

performed to the extent necessary and appropriate. Validation generally took the form of

comparing an actual invoice or a bill with data from the utility’s systems to ensure accuracy.

I.3 Organization of the Report

Section II of this report discusses the lags associated with the Company’s collections of

revenues. Included in Section II is a description of the sources of such revenues and how they

were treated for the purposes of deriving an overall revenue lag as it affects the Company’s

transmission operations.

Section III presents a description of the various expenses and their attendant lead times.

Included in the discussion on expense leads are the lead time on OM&A costs, removal costs,

environmental remediation costs, interest on long term debt, Capital, Income, and Large

Corporation Taxes, and the Goods and Services Tax (or “GST”). The methods used to calculate

the expense lead times associated with each of the items as well as the results from the

application of the methods are described.

Section IV presents the cash working capital requirements of Hydro One’s transmission

business.

Finally, Section V presents the results of a high‐level benchmarking of Hydro One’s

Transmission lead‐lag studies with other studies that have been conducted in Canada. The

question addressed in the benchmarking effort is whether other studies within Canada

considered the various elements of revenues and expenses considered by the Company and

thus, reinforce the reasonableness of the approach taken by Hydro One in this study.

II. REVENUE LAGS

Revenue lags measure the time period between when Hydro One’s Transmission

business provides service and when revenues from such services are collected. Based on

invoice and payment data, as well as an analysis of aging of accounts receivable, a revenue lag

of 36.96 days was determined.

Hydro One’s transmission business realizes revenues from two sources:

1. From the Ontario Independent Electric System Operator (“IESO”) for

transmission services provided. These revenues represent approximately 97.5

percent of total transmission revenues realized by Hydro One’s transmission

business.

2. From other sources including maintenance work, engineering and contract

services, secondary land use, telecommunications, special studies, and royalties

from the use of the Company’s proprietary software. These revenues represent

approximately 2.5 percent of total transmission revenues realized by Hydro

One’s transmission business.

According to its Billing and Settlements manual, the Ontario IESO is required to make

monthly remittances to Hydro One for transmission services provided. A schedule for such

remittances is provided in Chapter 9 of the IESO Market Rules for the Ontario Electricity Market

manual. Based on the IESO remittance schedule and using actual amounts for dollar‐weighting,

the revenue lag associated with remittances from the IESO was determined to be 35.15 days.

Relying on the mid‐point approach, this revenue lag includes 15.21 days of service lag time

since the period of service is monthly (i.e., 365 divided by 12 divided by 2)

An accounts receivable (“AR”) report for the period ending January 3, 2006 together

with information regarding the Company’s write‐off policy was used to determine the lag time

associated with other revenues. Based on information provided in the AR report (which

provides information on dollars outstanding by vintage) a revenue lag time of 107.98 days was

determined for other revenues. Using the mid‐point approach, this estimate of lag time on

other revenues includes a ½ month of service lag (or 15.21 days) since services are generally

provided by the Company to its customers in the month prior to billing

The separate revenue lags were then dollar weighted by their respective share of total

transmission revenues in Calendar year 2005 to derive a weighted average revenue lag of 36.96

days for the transmission business. This derivation is shown in Table 1 below.

Table 1

Calculation of Revenue Lag

Source of Revenue Lag Time (Days)

Revenues (Mil $)

Weighting Factor Weighted Lead Time (Days)

(A) (B) (C) (D) (E)= (B) * (D) IESO 35.15 1,296 97.5 % 34.28 Other 107.98 33 2.5% 2.68 1,329 36.96

III. EXPENSE LEADS

As mentioned at the outset, a determination of working capital requires both a

measurement of the lag in the collection of revenues for services provided by Hydro One’s

transmission business, but also the lead times associated with payments for services provided to

the Company. In conjunction with the calculation of the revenue lag therefore, expense lead

times were calculated for the following items:

a. OM&A expenses

b. Removal Costs

c. Environmental Remediation

d. Interest on Long Term Debt

e. Income, Capital, and Large Corporation Tax, and

f. GST

III.1 OM&A Expenses

For the purpose of the transmission lead‐lag study, OM&A expenses were considered to

consist of payments made by Hydro One in the following categories:

a. Payroll and Benefits expenses

b. Payments made to Consulting and Contract Staff

c. Payments made to Inergi

d. Lease Payments made on the Trinity Office Building

e. Property Taxes

f. Corporate Procurement Card payments, and

g. Other (Miscellaneous) Operations and Maintenance related payments.

Expense lead times were calculated individually for each of the items (a) – (g) listed

above and then dollar‐weighted to derive a composite expense lead time of 19.21 days for

OM&A expenses. The derivation of the composite expense lead time is shown in Table 2

below.

Table 2

Calculation of Transmission OM&A Expense Lead Time

Line No.

Description 2005 Actual TX related Expenses (Mil $s)

Weighting Factor

Expense Lead Time (Days)

Weighted Expense Lead Time (Days)

(A) (B) (C) (D) (E) = (C) * (D)

1 Payroll and benefit costs 152 45% 21.863 9.74

2 PRB excess accrual over payments4 17 5% 0.00 0.00

3 Payments to Consulting and contract staff 20 6% 56.92 3.33

4 Payments to Inergi 25 7% 2.61 0.19

5 Payments for Trinity 2 1% (15.46) (0.09)

6 Property taxes 59 17% (4.35) (0.75)

7 Procurement Card Payments 31 9% 35.92 3.24

8 Other (Miscellaneous) Operations and Maintenance 36 11% 33.79 3.55

9 Total OM&A 342 100% 19.21

III.2 Payroll and Benefits

The analysis of the expense lead times associated with payroll and withholdings

considered each of the four payrolls in place at the Company including basic payroll,

construction payroll, management payroll, and the Board of Directors payroll. Withholdings on

account of the Canada Pension Plan, employment insurance, and income taxes were considered

for each of the four types of payroll.

Benefits payments made by the Company to its pension plan, payments made to cover

the Company’s group health, dental, and life insurance plan administration and claims related

costs, Employer Health Tax payments, and payments made to the Worker Safety Insurance

Board (“WSIB”) were also considered.

3 See Table 3, Col (E), Row 14 4 These amounts represent the excess of amounts accrued over amounts paid.

When all payrolls, withholdings, and benefits were dollar‐weighted using actual

payment data from calendar year 2005, the weighted average expense lead time associated with

payroll and benefits was determined to be 21.86 days. The calculation of the weighted lead time

for payroll and benefits is shown in Table 3.

Table 3

Calculation of Hydro One Inc. Payroll and Benefits Expense Lead Time

Line No.

Description Total Company Payment Amounts (000s)

Expense Lead Time (Days)

Weighting Factor

Weighted Expense Lead Time (Days)

(A) (B) (C) (D) (E) = (C) * (D)

1 Pensions $ 82,541 45.29 14.49% 6.56

2 Group Health and Dental ASO: 8,339 39.38 1.46% 0.58

3 Group Health and Dental ‐ Claims: 35,213 9.96 6.18% 0.62

4 Employer Health Tax: 8,878 30.46 1.56% 0.47

5 WSIB Payments: 3,777 45.15 0.66% 0.30

6 Basic Payroll 188,681 18.50 33.12% 6.13

7 Management Payroll 28,043 (0.65) 4.92% (0.03)

8 Construction Payroll 63,607 11.50 11.17% 1.28

9 Board of Directors Payroll 326 60.12 0.06% 0.03

10 Payroll Withholding ‐ Basic Payroll 101,950 26.02 17.90% 4.66

11 Payroll Withholding ‐ Management Payroll 18,511 7.46 3.25% 0.24

12 Payroll Withholding ‐ Construction Payroll 29,635 19.29 5.20% 1.00

13 Payroll Withholding – Board of Directors Payroll 138 68.25 0.02% 0.02

14 Total $ 569,640 21.86

III.3 Payments made to Consulting and Contract Staff

Consulting and Contract staff provide a spectrum of services to the Company in the

areas of engineering, environmental services, receivables management, accounting, and general

consulting. Based on an analysis of a sample of actual invoices from vendors of consulting and

contract services and the Company’s payment practices, a dollar‐weighted expense lead time of

56.92 days was determined. This weighted expense lead time took into account the mid‐point

of the period over which each consulting and contract service was provided to the Company.

III.4 Payments to Inergi

Inergi provides six major services to Hydro One: Customer Service Operations, Finance,

Human Resource Services, Information Technology, IESO Settlements, and Supply

Management Services. Based on actual payments made by the Company in calendar year 2005

to Inergi for each of the six services, and using a mid‐point approach for calculating the service

lead time, a dollar‐weighted expense lead time of 2.61 days was determined.

III.5 Payments for Trinity

The Company leases its head office space in the Bell Trinity Square building from an

outside party. During 2005, the outside party changed from Oxford Properties to Northam

Properties, however, the lease payment schedule remained the same after the transition. The

Company makes its lease payment at the end of the month prior for the current month. Using

actual invoicing and payment data from 2005, a dollar‐weighted expense lead time of negative

(15.46) days was determined. Since lease payments are monthly, the estimate of weighted

expense lead time includes a ½ month of service lead time (or, on average, 15.21 days).

III.6 Property Taxes

The Company makes property tax payments to a number of municipalities within the

province of Ontario. These payments are generally in installments and occur at varying times

during any given year for the current year. Using actual payment dates and payment amounts

in 2005, a dollar‐weighted expense lead time of negative (4.35) days was determined for

property taxes. Since property taxes are due annually, the mid‐point of a year was used as

indicative of the service lead time associated with property taxes.

III.7 Procurement Card Payments

Procurement (or Charge) cards are used by the Company’s employees for a variety of

Company‐related reasons including, but not limited to, purchases of materials in the field,

incidental expenses, and travel and accommodation. Based on actual invoicing and payment

dates that occurred in 2005, a dollar‐weighted expense lead time of 35.92 days was determined.

Since the Company receives a monthly bill for the service, the weighted expense lead time

includes an additional ½ month of service lead time.

III.8 Other (Miscellaneous) Operations and Maintenance Expenses

This category was used to examine the expense lead time associated with a sample of

miscellaneous operations and maintenance related expenses invoiced and paid in 2005.5 Both

product purchases as well as the provision of services were examined within this sample.

Based on a sample of approximately 370 invoices which included product purchases,

equipment rentals, annual subscriptions, a dollar‐weighted expense lead time of 33.79 days was

determined. As with other categories of OM&A expenses, a mid‐point approach (generally

using time periods shown on vendor invoices) was used to determine the respective service

lead time associated with the delivery of both products and services to the Company.

III.9 Removal Costs

The Company incurs costs when removing or replacing equipment from existing sites or

rights of way to replace with newer equipment. While these costs are required to be reported as

depreciation expense for accounting purpose, there is a cash flow impact in any given year

associated with expenditures on removals.

In interviews with the Company, it was determined that about 36 percent of total

removal costs relate to the Company’s labor; the remaining 64 percent relate to other

(miscellaneous) operations and maintenance expenses. Taking this information into account, a

weighted expense lead time of 29.49 days was determined. The weighted expense lead time

was calculated using the formula:

(36 percent * Payroll and Benefits Expense Lead) +

5 This category of operations and maintenance expenses excludes data on payroll and benefits, payments to Inergi, payments to consulting and contract Staff, Trinity lease payments, property taxes, capital, income, and large corporation tax, GST, or procurement card payments.

(64 percent * Other (Miscellaneous) Operations and Maintenance Expense Lead).

III.10 Environmental Remediation

The Company incurs an expense when it is required to perform environmental

remediation of its existing sites. As with removals, such remediation costs are recorded on the

Company’s books as a depreciation expense but have a cash flow impact associated with them

during the current year. Since the process of remediation involves the procurement of materials

and services, the expense lead time associated with other (miscellaneous) operations and

maintenance expenses, i.e., 33.79 days, was used as indicative of the expense lead associated

with environmental remediation.

III.11 Interest on Long‐Term Debt

The Company incurs an expense when it is required to make interest payments on its

long‐term debt. Such payments are generally made by the Company semi‐annually. Taking

into account known changes such as the maturity of existing long‐term debt as well as the

(potential) issuance of new debt over the period 2006‐08, the dollar‐weighted expense lead time

associated with the Company’s interest payments on its long‐term debt outstanding was

determined to be 53.30 days.

The analysis used a calendar‐year approach and computed the difference in time

between the payment due dates and the mid‐point of the respective calendar year(s) as

indicative of the expense lead time.

III.12 Income, Capital, and Large Corporation Tax

The Company makes income, capital, and large corporation tax payments in monthly

installments to the federal government. Using actual payment data from 2005, a dollar‐

weighted expense lead time of 14.08 days was determined for Capital tax. The corresponding

value for Income and Large Corporation Tax was 15.96 days. Both estimates include ½ month

of service lead time in the calculation, since payments are made in monthly installments.

When capital and income and large corporation taxes are dollar‐weighted together using

actual payment amounts in 2005, the resulting value for the combined Income, Capital, and

Large Corporation tax was 15.68 days.

III.13 Goods and Services Tax (GST)

The expense lead times associated with the following items that attract GST were

considered:

a. Revenues received by the Transmission business b. Corporate Procurement Card c. Payments for Trinity d. Payments to Inergi e. Other (Miscellaneous) Operations and Maintenance related payments f. Payments to Consulting and Contract Staff, and g. Payments for removals, environmental remediation, and capital

A summary of the expense lead times associated with each of the above items are provided

in Table 4. A statutory approach was taken to determine the expense lead times associated with

the Company’s remittances and reimbursements of the GST, i.e., the last day of the month

following the date on its invoice.

Table 4

Expense Lead Times associated with GST

Line No. GST Category Expense Lead Time (Days)

1 GST ‐ Transmission Revenues (46.08)6

2 GST ‐ Procurement Card 13.36

3 GST ‐ Payments for Trinity 43.50

4 GST – Payments to Inergi 43.46

5 GST – Other (Miscellaneous) Operations and Maintenance 43.51

6 GST – Payments to Consulting and Contract Staff 42.06

7 GST ‐ Environmental Remediation 43.51

8 GST – Removals 43.51

9 GST – Capital 43.51

The expense lead times associated with the Corporate Procurement Card, Payments to

Trinity, Payments to Inergi, Consulting and Contract Staff payments, and Other (Miscellaneous)

Operations and Maintenance were then aggregated on a weighted basis into a single expense

lead time using 2005 actual GST payments. The aggregation, which resulted in a weighted lead

time of 42.73 days, is shown in Table 5.

Table 5

Weighted Lead Time on GST

Description 2005 Actual Hydro One Expenses (Mil $s)

Weighting Factor

Expense Lead Time

(Days)

Weighted Expense Lead Time

(Days)

(A) (B) (C) (D) (E) = (C) * (D)

Payments to Consulting and contract staff 20.0 17.6% 42.06 7.41

Payments to Inergi 24.9 21.9% 43.46 9.54

Procurement Card Payments 1.9 1.7% 13.36 0.22

Payments to Trinity 30.8 27.1% 43.50 11.80

Other (Miscellaneous) Operations and Maintenance 35.9 31.6% 43.51 13.76

Total 113.5 100.0% 42.73

6 The expense lead time on Transmission revenues is shown as negative since these are amounts that the Company is required to remit to the appropriate authorities. Thus, by using a negative sign convention, GST on transmission revenues is treated a source of cash to the Company and as such, acts to lower its otherwise applicable working capital requirement.

IV. WORKING CAPITAL REQUIREMENT

Having calculated the revenue lag, expense lead, and the net lag times, the next step in

the process was to calculate the Company’s working capital requirement. Using the results

described under the discussion of revenue lags and expense leads, and applying them to the

Company’s proposed transmission expenses for the test years 2007 and 2008, the Company’s

working capital requirements are $12.4 million in 2007 and $11.7 million in 2008. These

amounts represent 3.10 percent, and 3.02 percent of the transmission business’ OM&A expenses

respectively. A summary of the Company’s transmission business working capital

requirements is provided in Table 6.7

Included within the working capital amounts shown in Table 6 are GST offsets of $5.2

million, and $5.0 million for the period 2007‐2008. The derivation of these amounts is shown in

Table 7.

7 Note that this report provides substantiation for the data provided in Cols (A) – (C) of Table 6.

Table 6

Summary of Results

(All Data in 000s except Lead/Lag Days)

8 See Table 7 9 See Table 7

Revenue Lag (Days)

Expense Lead (Days)

Net Lag (Lead) (Days)

Test Year TX Expense

2007

Test Year TX Expense

2008 (A) (B) (C) (E) (F)

EXPENSES

OM&A Expenses 36.96 19.21 17.74 399,039 389,625

Removal costs 36.96 29.49 7.47 15,493 18,645

Environmental Remediation 36.96 33.79 3.17 4,300 4,100

Interest on Long term debt 36.96 53.30 (16.34) 204,915 214,666

Income, capital and large corporation tax 36.96 15.68 21.28 119,646 120,048

Total 743,392 747,084

GST8 38,879 36,890

Total amounts paid/accrued 782,270 783,974

WORKING CAPITAL REQUIRED (calculations based on above values, for each expense category, calculated using the following formula: Col (E) * Col (C)/365) OM&A Expenses 19,399 18,890

Removal costs 317 380

Environmental Remediation 37 36

Interest on Long term debt (9,175) (9,586)

Income, capital and large corporation tax 6,975 6,979

Total 17,553 16,699

GST9 (5,186) (4,950)

Net working cash required 12,366 11,749

Table 7

Derivation of GST Amounts

(All Data in 000s except Lead/Lag Days)

TEST YEAR 2007 TEST YEAR 2008

Line No.

6 percent GST 6 percent GST

BUDGET PROJECTION BUDGET PROJECTION

(A) (B) (C) (D)

GST CATEGORY

1 Revenue 1,263,294 75,798 1,297,643 77,859

2 OM&A Expenses 132,880 (7,973) 129,745 (7,785)

3 Removal costs 15,493 (930) 18,645 (1,119)

4 Environmental Remediation 4,300 (258) 4,100 (246)

5 Capital 462,645 (27,759) 530,314 (31,819)

6 Total 38,879 36,890

GST (BENEFIT) COST EXPENSE LEADS

GST AMOUNTS EXPENSE LEADS

GST AMOUNTS

The values shown in the Column labeled “GST Amounts” are calculated using the

expense leads shown in Col (A) rows 7-11 on the left divided by 365 and the 6% GST projection amounts shown in Column (B),

Rows 1-5 above

The values shown in the Column labeled “GST Amounts” are calculated using the expense

leads shown in Col (C) rows 7-11 on the left divided by 365 and the 6% GST projection

shown in Column (D), Rows 1-5 above

7 Revenue (46.08) (9,570) (46.08) (9,803)

8 OM&A Expenses 42.73 933 42.73 909

9 Removal costs 43.51 111 43.51 133

10 Environmental Remediation 43.51 31 43.51 29

11 Capital 43.51 3,309 43.51 3,782

12 GST (BENEFIT) COST (5,186) (4,950)

V. COMPARING THE HYDRO ONE TRANSMISSION LEAD‐LAG STUDY WITH OTHER CANADIAN STUDIES

The purpose of this section is to present the results of a comparison of the Hydro One

transmission business lead‐lag study with other studies that have been performed within

Canada. The intent of performing the comparison is to provide a high‐level determination of

the reasonableness of the Hydro One’s transmission study. Reasonableness, as defined here,

includes a) consistency with other studies performed within Ontario and the remainder of

Canada, and b) creating a balance between the needs of customers and investors when deriving

working capital requirements.

Hydro One’s transmission lead‐lag study is compared with studies performed for both

electric and natural gas companies which do business either at the wholesale or retail level in

Canada. Studies that are compared with the Hydro One’s transmission study include those

performed for Great Lakes Power (or “GLP”), Enbridge, Union Gas, FortisBC, ATCO, Direct

Energy, Altalink, FortisAlberta, Pacific Northern, and EPCOR.

Table 8 presents a high‐level comparison of the Hydro One transmission study with

other similar studies conducted within various Canadian jurisdictions. To the extent that

certain elements of Hydro One’s transmission study do not apply to others (e.g., in the instance

of natural gas companies), they have been so noted within Table 8.

Table 8 Benchmarking the Hydro One Transmission Lead‐lag Study

ENTITY Hydro One

TX GLP Enbridge Union FortisBC ATCO Direct

Energy AltaLink Fortis

Alberta Pacific

Northern EPCOR

JURISDICTION Ontario Ontario Ontario Ontario BC Alberta Alberta Alberta Alberta BC Alberta

LINE OF BUSINESS Electric TX Electric TX Gas Gas Electric Gas Electric Electric TX Electric TX Gas Electric TX

Customer Revenues N/A N/A Yes Yes Yes Yes N/A Yes Yes Yes N/A

IESO/ISO Revenues Yes Yes N/A N/A Yes N/A N/A Yes Yes N/A Yes

Other Revenues Yes Yes N/A N/A Yes Yes N/A Yes Yes Yes N/A

Payroll, Withholdings, and Employee Benefits

Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes

Cost of Power or Other fuels

N/A N/A Yes Yes Yes Yes Yes N/A N/A Yes N/A

Other OM&A Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes

Income and Related Taxes

Yes No No No Yes Yes No Yes Yes Yes No

Taxes Other Than Income

Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes

Interest Expense Yes No No No Yes Yes No Yes Yes No Yes

To create, to the extent possible, a level playing field, the following items considered

within the Hydro One transmission study are discussed with regards to other studies:

1. Revenues from customers (“Customer Revenues”) 2. IESO/ISO Revenues 3. Other Revenues 4. Payroll, Withholdings, and Employee Benefits 5. Cost of Power or Other Fuels 6. Other Operations, Maintenance, and Administration expenses including

environmental and removal costs 7. Income and related taxes 8. Taxes Other Than Income 9. Interest expense

V.1 Customer Revenues

In order to consider customer revenue in a lead lag study, customers must settle

payment directly with the Company. This is not the case with Hydro One Transmission

as settlement is solely with the IESO. Thus, the Hydro One transmission study did not

consider revenues from retail customers10.

V.2 IESO/ISO Revenues

Hydro One’s transmission lead‐lag study took into account revenues from the

Ontario IESO as did all other electric transmission studies. As can be seen in Table 8,

this item is an “N/A” (Not Applicable) in the studies performed for the natural gas

companies or for electric companies operating in provinces without a functioning

independent system operator. Hydro One’s transmission lead‐lag study is therefore

consistent with other lead‐lag studies performed both in Ontario and within other

Canadian jurisdictions.

10 However, as can be seen from Table 8, two notable exceptions are Altalink and FortisAlberta, companies that have direct connect customers. As would be expected therefore, studies performed by Altalink and FortisAlberta tend to consider the lag in the collection of revenues from direct connect retail customers. All the natural gas studies that were reviewed considered customer revenues within their lead‐lag studies.

V. 3 Other Revenues

To the extent that other companies within Canada have other revenues, the

revenue lag time associated with such other revenues has been considered in their

respective lead‐lag studies. Among those companies examined include Great Lakes

Power (GLP), FortisBC, ATCO Gas, Altalink, FortisAlberta, and Pacific Northern. Thus,

the Hydro One transmission study is consistent with other studies that have been

performed within Ontario and the rest of Canada.

V. 4 Payroll, Withholdings, and Employee Benefits

All studies performed for other companies within Canada, took into account the

expense lead time associated with payroll, withholdings, and employee benefits. Thus,

the Hydro One transmission lead‐lag study is consistent with lead‐lag studies

performed by other companies both within Ontario and the rest of Canada.

V. 5 Cost of Power or Other Fuels

Since Hydro One’s transmission business does not serve retail customers, neither

the cost of power nor other fuels were considered. Studies performed for natural gas

companies in Canada include the expense lead times associated with natural gas

purchases in their studies. Electric companies, not necessarily limited to transmission

businesses, who serve retail customers, such as FortisBC and Direct Energy, do include

the expense lead time associated with the purchase of electric energy.

V. 6 Other OM&A Expenses

All studies against which the Hydro One transmission study was compared

include the expense lead time associated with Other OM&A expenses in their studies.

While specific items within the Other OM&A “bucket” might vary depending on the

specific company, the bucket in its entirety is considered as an offset to the revenue lag

in all of the studies reviewed. Thus, Hydro One’s transmission lead‐lag study is

consistent with other studies that have been performed in Ontario and other

jurisdictions in Canada.

It is important to note here that Hydro One is unique in that environmental and

removal costs are considered and shown separately in Table 6 as a contributor to

working capital requirements. As explained in Section V of this report, these costs are

reported as a depreciation expense on the Company’s books but have cash flows

associated with them in any given year. Had the Company not recorded and reported

them separately, these items would likely have been included under Other

(Miscellaneous) OM&A expenses when computing their respective weighted lead times

and, ultimately, their contribution to the Company’s working capital requirement.

V. 7 Income and Related Taxes

Hydro One’s transmission lead‐lag study may be unique in the sense that it

seems to be only entity in Ontario that includes the expense lead time associated with

income and related taxes as an offset to revenue lags, and therefore, an element of

working capital requirements. Alberta and British Columbia, on the other hand, do

include income and related taxes as a legitimate offset to revenue lags and therefore, an

element of working capital. Even to the extent that the Hydro One transmission study

may be unique in its inclusion of income and related taxes, its consideration is

reasonable as a) income and related taxes is a legitimate expense of the Company and, b)

since its weighted expense lead time is less than the revenue lag time, investors are

provided with a return on the funds provided to make the tax payments during the

course of a year.

V. 8 Taxes Other Than Income

All studies against which the Hydro One transmission lead‐lag study was

compared include the expense lead time associated with taxes other than income. While

some of the studies may be limited to a calculation of the net expense lead time

associated with the GST, others include provincial taxes, property taxes, and other forms

of ad valorem taxes in their studies. Thus, the Hydro One transmission lead‐lag study is

consistent with other studies that have been performed in Canada.

V. 9 Interest Expense

Again, Hydro One’s Transmission study may be unique within Ontario as it

considers interest expense as an offset to revenue lags when deriving working capital.

Interest expense was considered by British Columbia (FortisBC) and by multiple

companies within Alberta (see Table 8). As with the case of income and related taxes,

even to the extent that the Hydro One transmission study may be unique, consideration

of interest expense is reasonable as a) it is a legitimate expense of the Company and, b)

since its weighted expense lead time is greater than the revenue lag time, funds to make

interest payments are generally customer supplied and thus interest expense is an offset

to the otherwise applicable working capital requirements of the Company.

Conclusion: Reasonableness of Hydro One Transmission Lead‐lag Study

As mentioned at the outset, the purpose of performing the benchmarking

described in this section was to determine whether the Hydro One transmission lead‐lag

study was “reasonable”. From the discussion contained in this section, it is evident that

the items considered in the Hydro One transmission lead‐lag study are consistent with

items that have been considered in other lead‐lag studies within Canada. To the extent

that there are differences, they can be explained as not being relevant to a transmission

company’s operations or to the operations of an electric company.

Finally, where there are elements of the Hydro One transmission study that are

unique compared with other studies that have been performed within the Board’s

jurisdiction such as income and related taxes and interest expense:

1. They have been considered and included in the determination of working capital

in other jurisdictions within Canada.

2. Their inclusion makes sense because consideration is given to working capital

contributions made by both customers (funds to make interest payments) and

investors (funds to make income and related tax payments). Thus, a balance

between the needs of customers and investors when deriving the working capital

requirements of Hydro One’s Transmission business is achieved.

working capital and lead/lag - hydro one · updated: february 23, 2007 eb-2005-0501 exhibit d1 tab...

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